The Federal Reserve is slowly moving into the next phase in its fight against inflation | ET REALITY

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Federal Reserve officials are expected to leave interest rates unchanged at their meeting on Wednesday, buying more time to assess whether borrowing costs are high enough to hurt the economy and control inflation.

But investors are likely to focus less on what authorities do on Wednesday and more on what they say about the future. Wall Street will be watching closely whether Fed policymakers still expect to make another interest rate hike before the end of the year or whether they are approaching the next phase in their fight against rapid inflation.

Central bankers have already raised interest rates to a range of 5.25 to 5.5 percent, the highest level in 22 years. By making it more expensive to borrow to buy a home or expand a business, they are trying to slow demand across the economy, making it harder for companies to charge more without losing customers and slowing price increases.

Officials predicted in their latest quarterly economic forecast, released in June, that they would likely make one more rate hike before the end of 2023. They have kept that possibility alive all summer, even as inflation has begun to decline significantly. But top policymakers have been less determined to take further action in recent weeks.

Federal Reserve Chairman Jerome H. Powell had suggested in June that further adjustments were necessary.likely.” More recently, including during a widely watched speech in August, he said policymakers could push rates higher.”if appropriate.

Fed officials will release economic projections after their meeting this week, which will take place on Tuesday and Wednesday, offering a new look at whether most policymakers still believe a final hike in interest rates is likely to be necessary. rates. The projections will also show how officials are interpreting a confusing time in the economy, when consumer spending has been stronger than many economists expected, even as inflation has cooled a little more quickly.

Taken together, the revised forecasts, the Fed’s statement and a news conference with Powell after the meeting could give the clearest signal yet on how close the central bank believes it is to the end of rate hikes. , and what will be the next phase to try it. what it might look like to completely fight inflation.

“In recent weeks, many centrist Fed officials have said: We are close to where we need to be; we may even be there,” said Michael Feroli, chief U.S. economist at JP Morgan.

Feroli believes there is about a two-thirds chance that policymakers will continue to predict another rate move, and a one-third chance that they will predict that the current situation is likely to be the peak interest rate.

But even if the Federal Reserve signals that interest rates have peaked, officials have made clear that they are likely to remain elevated for some time. Officials think that simply keeping rates high will continue to weigh on economic growth and gradually cool the economy.

Feroli doesn’t expect officials to start talking too decisively about the next phase (in which rates drop) just yet.

“They haven’t won the war against inflation, so it would be a little premature,” Feroli said.

That said, economic forecasts could offer some clues. Federal Reserve officials will release their projections for interest rates in 2024, 2025 and (again) 2026 after this meeting. In June, its projections for 2024 had suggested that officials expected to reduce borrowing costs fourfold next year. The question is when in the year those cuts will occur and what officials should see to feel comfortable lowering rates.

Authorities could offer little clarity on those points Wednesday, hoping to avoid a big market reaction, one that would make their job of cooling the economy more difficult.

If stocks were to soar as markets generally began to anticipate that the Federal Reserve-induced financial and economic contraction was likely to come sooner, it could make borrowing money cheaper and easier for businesses and households. That could speed up the economy as the Federal Reserve tries to slow it.

Growth has already been surprisingly resilient to the Federal Reserve’s high rates. Consumers and businesses have continued to spend at a healthy pace despite many economic risks to the outlook, including the resumption of federal student loan payments in early October and a possible government shutdown after the end of this month. .

Leftover household savings following the pandemic, a strong labor market with strong wage growth, and various government policies aimed at spurring investment in infrastructure and green energy may be helping to fuel that momentum.

The resilience could prompt another revision to the Federal Reserve’s economic forecasts on Wednesday, Goldman Sachs economists said: Officials could raise their estimate of the so-called neutral rate, which indicates how high interest rates must be to weigh on the economy. economy. . That would suggest that while the policy was constraining the economy today, it was not doing so as intensely as officials would have hoped.

The economy’s staying power could also prevent policymakers from appearing too enthusiastic about the recent slowdown in inflation.

Consumer price index increases have cooled noticeably over the past year (to 3.7 percent in August, down from 9.1 percent at their 2022 peak) as pandemic shocks fade and Prices of goods that were in short supply fall or grow more slowly.

The Federal Reserve’s preferred gauge of inflation, which is released later than the Consumer Price Index measure, is expected to have slowly risen monthly in August after food and fuel prices were removed to give a clearer idea of ​​the inflation trend. .

The moderation is certainly good news: It makes it more likely that the Fed will be able to slow the economy enough to cool price increases without tanking the economy. But policymakers may worry about completely eradicating inflation in an economy that is still growing strongly, said William English, a former Federal Reserve economist who is now a finance professor at Yale.

If consumers are still willing to spend, companies may find that they can still raise prices to increase or protect profits. With this in mind, officials may believe that a sharper economic slowdown will be necessary to bring inflation down to its 2 percent target.

“The economy stayed strong longer than they thought,” English said. With this in mind, Fed officials may argue that their next move is more likely to be a rate hike than a rate cut.

English is skeptical that Federal Reserve officials think they can completely cool price increases without a further economic slowdown.

“I doubt they are expecting, as is their most likely forecast, that they are going to get unblemished disinflation,” he said. “I think that’s still your base case: the economy really has to have a period of fairly slow growth.”

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